Tuesday, 9 April 2013
The Harrod Domar Model in 7mins
What is HD model?
The Harrod Domar Growth model is a model not a growth strategy. A model helps to explain how growth has occurred and how it may occur again in the future. Growth strategies are the things a government should be doing to try and replicate the outcome suggested by the model. The model, developed in the late 1930s states that the rate of growth of GDP is determined by the savings ratio (the marginal propensity to save) in the economy and the capital output ratio (the amount that has to be spent on capital to produce £1 worth of national output (productivity of investment)
There are 10 assumptions of the HD, which also provide the main criticisms of the HD model.
1. There exists a relationship between capital and growth, the evidence on this is mixed and questionable.
2. There is unlimited supply of unemployed labour, this assumption fails to take into consideration the informal sector.
3. That production is proportional to the amount of machinery
4. The model discuss the need for savings and investments for growth, this implicitly assumed the existence of institutions.
5. Capital has no diminishing returns, what about depreciation identified in the Solow model.
6. No government intervention.
7. There is a closed economy.
8. Price levels are constant
9. Due to depreciation and gestation lags, this is not necessarily true that savings is equal to investment
10. Savings is no way define, making it problematic to apply.
Rate of Growth of GDP = Savings ratio/Capital output ratio
S = sY - savings is a function of national income
I = ∆k - net investment is defined as changes in capital stock
but as we assume direct relationship between k and y, we get the ratio of k/y = c
c is the capital output ratio thus ∆k/∆y or ∆k= c ∆y I= S, S=sy , ∆k= c ∆y so we get sy= c ∆y
divide by c and y ; s/c = ∆y/ y
changes in growth = savings ratio/capital ratio (affect of investment on national productivity)
It concluded that:
Economic growth depends on the amount of labour and capital.
As LDCs often have an abundant supply of labour it is a lack of physical capital that holds back economic growth and development.
More physical capital generates economic growth.
Net investment leads to more capital accumulation, which generates higher output and income.
Higher income allows higher levels of saving
In order to increase savings:
1. Aid can be used
3. This is similar to the Marshall Plan, where the US gave specifically for the redevelopment of Europe after the war and the aid was used via investment.
In order to increase the capital output ratio:
1. Government planning should be used to facilitate savings
2. HD would support the idea of economic investment planning as it ensures that capital can be used for investment , an example of this would be India's 5 year plan
1. The Marshall Plan worked for Europe because Europe possessed the necessary structural, institutional and attitudal conditions e.g. a well integrated money market in order to convert capital into output.
2. In some countries it is inappropriate to suggest increasing savings when people are struggling to get enough food.
3. Later on, Harrod repudiated the model as he did not see it fit with the idea of Long Run growth.
4. Ignores labour productivity, technological innovation and levels of consumption.
5. Thailand is a case study which experienced rapid growth despite the lack of savings.